Growth forecasts for the UK and Europe have been revised downwards. Last year, growth in the UK economy was forecast at 3% for the year 2012/13. The continued recession and a failure by the Conservative government to reduce the UK Budget deficit despite strict austerity measures has led to a reduction in next year’s growth projections to 1.5%. The UK reported its first year of contraction in 2009 and has continued to report low levels of growth to date.
The poor performance in the UK has been replicated across much of Europe and North America. In fact the best performing G7 economy has been Canada with 4% growth last year. Canada has benefitted from a strong manufacturing base and has several strong performing energy and mining companies to drive its economy forward.
Growth in Europe has been substantially lower than in the UK. Europe is forecast to show minimal growth in 2012-13, most of which is attributed to Germany which continues to grow despite the troubles in the Southern European economies. Growth figures estimate that the Europe will contract in 2012 and grow a paltry 0.1% in 2013.
Economists believe that there is a strong relationship between a country’s GDP and the flow of credit. It is therefore assumed that the tight restrictions over credit in Europe have led to the weakening economic plight in the UK and other Eurozone member states.
The US economy is forecasted to grow at 2% in 2012. However, the US has significant debt which must be deleveraged. Unless something is done, the US economy is forecast to reach a “fiscal cliff” in 2013 and will fall back into recession. The Fed have already engaged in a new a new policy of “unlimited quantitative easing” in a bid to stimulate the labour market and it is likely that the US will implement significant tax policy changes early next year in order to address the issue.
Despite the economic woes, it is believed that Europe is on its way to long term economic recovery. Mario Draghi’s new policies have been accepted by the market. The ECB will buy sovereign bonds in order to shore up the weaker European banks. A European Banking Union is also being discussed to restore confidence in the markets. Whilst a recovery is due, it will take longer than originally anticipated and 2013 is expected to be a period of slow growth.
The UK on the other hand is in a worse position now than during the Great Depression. The current squeeze on disposable incomes has been compounded by increases in VAT, fuel and food prices together with near zero interest rates. Household consumption has been squeezed and the economy has fallen into a double dip recession. Prices have gone up but wages have fallen and private investment is low.
Whilst productivity is low, employment in the UK remains resilient. Bankruptcies have not gone up because banks have not pulled the plug on underperforming businesses for fear of crystallising further losses on the bank’s balance sheets. We now have a risk that there are too many zombie companies in the UK that are simply not productive enough. Either that or the UK has spare capacity and this is a temporary lull in the market. The risk with zombie companies is that unless you let them go bankrupt you will not allow leaner more dynamic companies to develop and strengthen the economy.
The Bank of England is unlikely to meet its inflation target of 2% due to the quantitative easing employed earlier in the year. We do not expect the Bank of England to employ more quantitative easing in the near future for fear of inflation going through the roof. Similarly, interest rates are expected to remain low for a long period of time. This is disappointing because we cannot see how the economy will recover unless interest rates are brought back up. However, it is easy to understand the reasons for the BOE’s wait and see approach.
Fiscal and monetary policy are critical to the UK economy. The Budget deficit must be cut as planned. There is a risk that the UK’s AAA credit rating could be downgraded if this cannot be achieved. The UK plan to reduce the deficit to zero over 5 years. This is an aggressive policy but has been received very well by the markets. The history of inflation and QE mean that Sterling is exceptionally weaker than it used to be and this is forecast to continue.
Moody’s suggest that 2 factors could lead to a downgrading of the credit rating in the UK: Slow economic growth, or a u-turn in economic policy should the UK fail in its ability to tackle the deficit.
Private investment in the UK economy is very weak. This had led to several new government initiatives to promote investment. The new Seed investment Scheme (or SEIS) is an example of this. The government has also announced a new “funding for lending initiative” whereby £2.5 billion has been earmarked for the UK retail banks should they make loans to small businesses.
The negative sentiment from the Eurozone is affecting the UK economy as investment is held back during this period of uncertainty. This enhances the debate as to whether the weaker EU nations should be allowed to leave the Eurozone in order to restore confidence in the Euro. However, if Greece for example were to leave the Euro, this would set a dangerous precedent and would serve to increase the risk of a flight of capital from other EU countries such as Ireland, Portugal, Italy and Spain. Germany and France have huge exposure to the Eurozone and will do their upmost to prevent this from happening. The recent ban of short selling the Euro is just one of many attempts to restore confidence in the market.
Monday, October 29, 2012